Fonterra confirms ‘heightened focus’ on China farms

Fonterra Cooperative group is making headway into its strategic review, confirming it will take back full ownership of the Darnum plant by the end of the year, saying ownership of Tip Top is under the microscope and that its under-performing Chinese farms are a source of "heightened focus".

The dairy giant said it is considering a range of options for the ice cream business, which needs a level of investment Fonterra's unwilling to make "to take it to its next phase." It has appointed First NZ Capital as its external adviser.

Chief executive Miles Hurrell told BusinessDesk the cooperative doesn't yet have a view on the outcome but "our preference is to keep New Zealand ownership of course, but how much we sell down, to what extent, over what time frame is still to be determined," he said.

Fonterra officials also wouldn't be drawn on the cost of pulling out of the joint venture with Beingmate. Chair John Monaghan said an agreement in principle has been reached with Beingmate where Fonterra takes full ownership of the Darnum plant by the end of the year, and signs a multi-year agreement for Beingmate to purchase ingredients.

The joint venture - 51 percent owned by Beingmate and 49 percent Fonterra - produced infant formula products at the Darnum plant in Australia for Beingmate's Chinese customers, and was a key component of Fonterra's plan to expand its reach into China's second and third-tier cities.

That Beingmate partnership included Fonterra taking a 19 percent stake in the Chinese firm for $750 million. That investment was written down by $405 million in the last financial year after several years of under-performance and has been under review since new leadership took over at Fonterra this year.

Chief financial officer Marc Rivers told BusinessDesk that "at this stage, we have reached the agreement in principle to take back full control and the details are to be finalised".

A third asset is also under the microscope, and Hurrell said the cooperative will update the market when the process was further advanced.

He reiterated that all aspects of the business are up for review, including the farms in China.

"We haven’t made a decision on divesting farms per se but what we have said is that all our businesses are under review and we will take a good hard look at them. Clearly, our farms business hasn’t been performing at the level we're at; that would suggest it's getting a heightened focus," Hurrell said.

The China farms include seven farms across two hubs with around 31,000 cows. In the 2018 financial year, the China farms recorded a direct loss of $9 million.

The dairy giant also said first-quarter gross margin was $646 million, down $14 million compared to the same period a year earlier, although up slightly on a percentage basis from 16.6 percent to 17 percent. Revenue fell 4 percent to $3.8 billion, and sales volumes were down 6 percent at 3.6 billion liquid milk litres equivalent.

Hurrell said Fonterra generally makes a smaller proportion of its total annual sales in the first quarter due to the seasonal nature of its milk supply. However, Fonterra also signalled some challenges in its Australian ingredients, Greater China foodservice and Asia foodservice businesses.

In Australia, Fonterra has seen lower milk collections as a result of drought conditions and increased competition for milk supply.

"We are responding by focusing on the performance levers in our control, the main one being reducing our operating expenses to reflect lower milk collections," Hurrell said. In it's latest global dairy update - also published today - Fonterra said Australian milk collection was down 12 percent in the four months to Oct. 31.

In the Greater China and Asia Foodservice businesses, Rivers downplayed any issues and said it was largely due to a "timing issue" because of high sales volumes of butter and cream cheese at the end of the prior financial year.

"We are coming off the back of last year, with quite high input costs with butter and fat prices being quite high. That’s started to come down but it's not coming through the food service results just yet. We expect to see that improve going forward," he said.

He added, however, the cooperative is "not taking that for granted" and "we have said that value is what's important. It's not about pushing volume."

The cooperative also lowered its forecast payout to its farmer shareholders due to global milk supply remaining strong relative to demand.

Fonterra expects to pay farmers $6.00-$6.30 per kilogram of milk solids versus a prior range of $6.25-$6.50/kgMS. It continues to expect it will collect 1,550 million kgMS in the current season, three percent more than last season. As a result of the drop in the forecast milk price, the payout will now be between $9 billion and $9.8 billion versus $9.69 billion and $10.08 billion if the old forecast had held.

Monaghan said the forecast assumes dairy prices will firm across the balance of the season. However, “there are still a number of unknowns in the global demand and supply picture and we recommend farmers budget with ongoing caution," he said.

NZX senior dairy analyst Amy Castleton said "the revision down is prudent given the current global dairy market situation." The volume of milk available around the world has kept pressure on global dairy commodity prices, she said.

Fonterra retained its earnings per share forecast of 25-to-35 cents.

Units in the Fonterra Shareholders Fund last traded at $4.71 and are down 27 percent so far this year.

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